USA Recession for Dummies

September 25, 2008 12:22 PM

I'm having a hard time understanding just what is happening to the US economy and why. I'm completely in the dark, I'm not familiar with the terminology, and I'm afraid.

Can someone either point me in the right direction or gently explain to me why things are looking so bleak, what the bailout means, how will life change for the average US or non-US citizen, and how McCain or Obama or anyone else might be able to help.

posted by ranunculus to law & government (14 comments total)

I don't know all that much about what is happening, but there is a lot of information over at the BBC News website. Here is a link to their latest article, see the right-hand sidebar for many in-depth articles.

Also, fellow MeFite Mutant is a highly knowledgeable source and often pipes up with very interesting comments on many financial topics.
posted by Vindaloo at 12:37 PM on September 25, 2008

The Big Pool of Money. The Economist offers good coverage of this stuff for laymen (if you understand some very simple economic terms and are willing to google stuff on occasion).
posted by phrontist at 12:38 PM on September 25, 2008 [1 favorite]

The gist of it is that a lot of people have defaulted on loans. En Masse this hurts the currency, the banks, and the credit markets. This can lead to rapid inflation and bank failure.

The government is planning to buy all the debt by infusing cash into failing lenders. Its unknown if this strategy actually will do anything.

My personal opinion is that the economy is such a complex thing that its practically a force of nature. I like to think of it like the weather. We can observe it and predict it, but not well, and we cannot control it.
posted by damn dirty ape at 12:43 PM on September 25, 2008

This is both perfect and awesome.
posted by chaosscontrol at 12:57 PM on September 25, 2008 [6 favorites]

Here is a good explanation of how we got here: Economic Disasters and Stupid Evil People.

The mortgage mess is the starting point. If you recall my posts on the mortgage mess, what happened was:

1. People like buying safe investments.
2. Historically, mortgages are very safe investments: people will go to incredible lengths not to lose their homes.
3. Banks realized that they could make lots of money by taking groups of mortgages, and turning them into bonds that they could sell, earning a commission, and passing the risk to whoever bought the bonds.
4. These bonds became incredibly popular. Lots and lots of people and organizations wanted to buy them.
5. There aren't enough good mortgages to put together the number of bonds that people wanted to buy.
6. So banks started giving out mortgages to people who couldn't repay them, using elaborate and dishonest schemes to pretend that they were actually not bad mortgages.
7. The people who got mortgages that they couldn't repay didn't repay them.
8. The banks act surprised: "My god, no one could have predicted that so many loans would default! Whine, whinge, moan, someone come help us!

What's going on now is directly related to that mortgage mess. A good metaphor for it is that the current situation is like a huge city of skyscrapers built on a foundation of sand; the mortgages are the sand.

The government is proposing to buy up a bunch of these complex, devalued instruments in the hope that this gets bad stuff off the companies' books, and infuses capital into companies that need it.

Paul Krugman's blog is full of criticism of this plan, including this: "I mean, any bank that wants to remove toxic assets from its balance sheet can do it at a stroke — just declare them worthless, and poof! they’re gone. But of course, that would reduce confidence and capital, not increase it — and that’s not what Hank and Ben are talking about. They’re talking about turning the assets over to Uncle Sam, and getting cold hard cash in return. And then the question is how much cash they get in return. It’s all about the price." And today: "My sneaking suspicion is that they started with a determination to throw money at the financial industry, and everything else is just an excuse."
posted by ibmcginty at 12:57 PM on September 25, 2008 [12 favorites]

Wikipedia's not really comprehensible, but it's worth a link.
posted by WCityMike at 1:18 PM on September 25, 2008

Here's the most concise, matter-of-fact explanation I've seen.
posted by mattholomew at 3:11 PM on September 25, 2008

Glenn Beck's piece is helpful as well: Financial meltdown is an absolute disaster.

I'm certainly not an expert - just following this like everyone else - so I might have this wrong.

But the gist of it, as I understand the scope of the problem moving forward, is that because of what the mortgage industry did, loans are drying up, and there may be a sort of snowball effect - when businesses can't get loans they cancel projects and hire fewer people, fewer jobs shrinks the economy (fewer people buying goods and services), which translates into fewer loans, more layoffs, further shrinking in the market, etc. That's why things are looking so bleak.

How this may impact us: More of us and our loved ones are unemployed, we've lost our houses, we don't have reliable income, crime goes up, services go down, etc. The world has become a small place, so it will be hard to contain the disease within the US. If hyper-inflation happens, our savings could have little or no value and it'll be hard for us to afford anything (the $100 loaf of bread problem other countries have faced). Also or alternatively, with the market plummeting, those with money invested could lose a lot of it.

The bailout is like a massive blood transfusion while the patient is still hemorrhaging - it's not clear whether it'll work. And part of what needs to happen for it to work is that the market "thinks" it'll work and reacts by reinvesting in the market.

How McCain, Obama, or anyone else could help? I'm not sure if they can, other than if they do/say something that will restore investors' confidence in the market. And if they help craft policy that will get us out of this mess and help us avoid a similar mess in the future.

I'm scared too. I'd like to hear a cogent, knowledgeable counter - why things aren't so bleak!
posted by Amizu at 3:33 PM on September 25, 2008 [2 favorites]

Why do people here think the crisis will increase inflation? People are in heavily in debt now and need dollars to pay off their mortgages. This should drive up demand for dollars, which could cause deflation. Japan had a similar mortgage crisis in the early 90s which lead to deflation that continued until the early 2000s.
posted by malp at 3:53 PM on September 25, 2008

malp, I think people believe that it will cause inflation because they see the government (potentially) spending $700 billion, and they know that the only way the government can get that money right now is to borrow it or "print" it.

"Printing money" being the problem. True, adding $700 billion dollars to the money supply would create inflation. However, that money increase is countered by the decrease in money seen by the devaluing of all these assets. Untold billions have disappeared- the genesis of the credit crunch- and the government believes that replacing some of this money will help.

To the other question- why aren't things so bleak? Because "the economy" is actually doing just fine. GDP is about flat over the last few quarters- meaning the economy is not growing, but it's also not shrinking. So when you take into account all the losses that have occurred in the financial sector, the rest of the economy must be growing by that much to have zero growth. There's $14 trillion dollars worth of business being conducted every year in the US, and if you look at it rationally, there's no reason to believe that anything happening right now is going to stop that. I would imagine that growth will remain flat for a while, however, because tighter credit means borrowing to grow is more difficult. And businesses that rely on expanding their debt, rather than actually creating value, will suffer. But that just means more opportunity for their competitors, who WILL grow.

It's all a big circle. Where there are losers, there are also winners.

And, not for nothing, the media is hyping this up beyond belief. As usual. Everyone loves saying how this is the worst thing since the great depression. And maybe it is- but the great depression was Really Bad. 25% unemployment. Negative GDP growth of 50% in three years. It's kind of like saying "this broken finger is the worst injury I've had since my legs were severed by a garbage truck." It would be laughable if it wasn't so sad.

Also, if you apply basic economics to the "OMG, nobody can get a mortgage anymore" hysterics you hear, it falls flat on its face. supply + demand = price, right? That implies there's more demand than supply. So if the ratio of supply to demand goes down, the price ought to go up. Think about it- if you have less money to lend and more customers than you know what to do with, and have an urgent need to make some profit, you charge more. That's just not happening. Mortgage rates are basically flat. And still historically low. Mortgage rates were well in the double digits for much of the 70's and 80's, without a mortgage meltdown to blame for it.
posted by gjc at 5:57 PM on September 25, 2008 [4 favorites]

Alan Greenspan set US interest rates very low. When interest rates are low, people can afford to take out bigger loans. That increased the number of people competing for any given grade of housing, which made house prices start rising. This rise was compounded as people bought houses as investments, often using interest-only loans, assuming that house prices were going to keep going up fast enough that when they sold the house later they'd make enough to pay out their loans and turn a tidy profit besides.

Increased demand for housing loans caused increased competition among lenders, who became involved in a race to the bottom to win borrowers. It became easier and easier to get a loan for speculation (not investment) in housing, regardless of actual capacity to pay the loan back; by and large, the lenders were also acting as if housing prices would just keep on rising forever and the dodgy mortgages they were issuing would be adequately secured by the houses they were lent for.

Financial middlemen bought a lot of these loans, aggregated them, had them given completely unsound risk ratings and sold them to large investors in unprecedented quantities.

But interest rates eventually got pushed up again, some people (mostly genuine home owners rather than speculators) began to be unable to service their mortgages, housing prices stopped rising, and the whole pyramid scheme is now well and truly collapsing.

So now, the very same institution whose interest rate manipulations have driven this whole farce wants to be put in absolute charge of about a trillion dollars' worth of your taxes, which it proposes to hand out like jelly beans to reward the main players in the pyramid scheme. Bush thinks this is a great idea, since he's friends with lots of these people. Congress will, as usual, be bamboozled into compliance. Congratulations, America - you've just been screwed again.
posted by flabdablet at 9:51 PM on September 25, 2008 [1 favorite]

If we focus JUST on the current financial debacle then what is happening is that there is a credit freeze…self-inflicted, so to speak. Unlike an individual household that may have managed their money incorrectly and find themselves in a financial bind, this is a national bind that is and will trickle down to all of America. How? Lending institutions are no longer lending freely as they once were. Primarily because of government laws requiring them to be “well capitalized” (this of course, goes with an equation that tells them how to be capitalized sufficiently).

Here’s just one scenario: John Doe farmer is ready to plant his commercial crop so that it will grow and months later he will harvest and sell for a profit. However, he doesn’t have the cash flow to buy the seed/fertilizer etc. etc.(for arguments sake we will say he wants to borrower $100,000.00) so he goes to his bank and asks for a “short term” loan to be repaid in approximately 150 days when his crop has sold on the market (based on history he expects $500,000.00 net profit). However, John Doe is told that the bank(s) do not have funds to loan OR that they won’t lend him the full amount (they may offer him $50,000.00). Keeping in mind this is just one of numerous farmers doing the same request at approximately the same time, what do you think the two scenarios will be?

1. He cannot get a loan, cannot plant, attempts to sell the farm (can’t sell because of the credit freeze-nobody can get a loan for what he is asking), files bankruptcy or allows the farm to be foreclosed on, attempts to get a job but everyone is laying off, goes on welfare (government paid).

2. OR he takes the $50,000.00 at a higher than expected interest rate because of the credit freeze (short term interest rates have been going up every day for the last 4 days)and plants only half of his expected crop. He gets only half the return, goes to market because of the credit freeze that his hit every other industry, he can only get, for example, $.75 on the dollar for his crop. So, instead of getting $250,000.00 as he expecting he gets $187,500.00. He has to pay back the loan of approximately $51,000.00 so he has $136,500.00 left to pay all the farm’s expenses, payroll, insurance, utilities etc. this year instead of a $398,000.00. It also means he delivers less food to market so in approximately 150 days from when this all began there is now a food shortage so the cost of food will increase to the consumer (you and me) but there will also be less of it. Chances are he cannot keep the farm going for another year on the left overs of the 187,500.00 so again, he is in the position of foreclosure or bankruptcy.

This same scenario happens in a small business or medium business like Hospital's. The difference is they go to the Bank for funds to start/complete a business project and need short term funds. For instance, the Medical Center of Virginia (MCV) has started construction on a building that in the long run will save MCV hundreds of thousands of dollars by moving departments that are scattered all over the city in various buildings to this one building and selling the other buildings or leasing them out. To get there they need the funds to pay the contractors that are building the building. They go to the bank for short term funds wanting to repay in 18 months when the building is completed and they start getting funds in from the sale of buildings or leases. The bank does not have the funds to loan. The building has already been started, the contractors want to be paid. MCV cannot pay them now so promises to pay them in, say 150 days. The various contractors (mostly small business) need to pay their staff and overhead; they go to the bank for short term funds for 150 days…nope, can't, why? credit freeze. The small business most likely does not have good credit so even if there were funds, the interest rates offered with mediocre credit will be too high to afford. Then this snowballs to the vendors that do business with those small businesses who cannot pay their van payments, utilities etc. The business goes out of business. Vendors take losses, they go to the bank for short term funds; no funds are available. By this time the banks are being “run on” meaning these business people (which also have personal accounts and knows there is a problem) start taking their funds out based on fear. So the banks never recover, government bailouts etc.

Does that make sense?

I have not heard the government plan yet so I don’t know what is proposed but I have heard it is very socialistic in that everyone, through taxes, will pay to get everyone out of debt. Basically, the funds given by the government would be used by banks to start lending again so the credit freeze would go away…for now. But you still have the bad debts and fraud and golden balloons that will need to be dealt with.

It is my opinion we are going to have to go through this instead of bailing out in order to put the country back on an even playing field again.

The Fannie/Freddie problem is even bigger than this one is. Because what would we be bailing out? They are high risk loans. There is talk about refinancing them to give the homeowner lower interest rates so they can make their payments. The interesting thing about this is that for the most part, all homeowners are making their payments. The default ratio is still low. The snowball has not hit them yet but it will.

Can someone either point me in the right direction or gently explain to me why things are looking so bleak, what the bailout means, how will life change for the average US or non-US citizen, and how McCain or Obama or anyone else might be able to help.

The bailout means huge tax increases, business going defunct because they cannot pay them etc. They cannot help. Especially if they support the bail out. I think they are trying to come up with what I call a stop gap measure but this is bigger than the government can permanently solve. What they are trying to do is get some liquidity going again. Right now there is NO money to lend except what is left in pipelines. If you read the small print of most credit cards and mortgages and home consumer loans (i.e car loans), ANY financial institution can call in your balance due and payable immediately if they choose to. You are in default if you don’t do that and there goes their credit rating. If a financial institution does not get bailed out, that may be what they have to do to stay afloat.

This is exactly what happened in the great depression. Those who planned for hard times will not have a hard time. Those who have been living hand to mouth will be the worst hit. The country is much bigger now with a lot more people dependent on the government. It won’t be pretty.

Here’s one last, more simplistic scenario that you might be able to relate to. In the game of Monopoly, if you were lucky enough to get a lot of properties and have had a lot of cash to purchase houses and hotels, then you had a beautiful set up. You were destined to win the game. However, if, by chance, you never made any money because the other players always seemed to miss your properties on their roll, and one other player happened, lets say, to own all the railroads (let’s say China owned them instead of USA) and you (USA with all the money) kept landing on the railroads; well then what little cash you had kept going to China and soon you find that you have a lot of properties that are worth nothing because now you are having to sell your houses and hotels just to stay in the game. That is a simplistic version of what is happening.

Hope this helps,
Take Care
posted by TeachTheDead at 7:46 AM on September 26, 2008 [2 favorites]

This explanation from Kiplinger.com did it for me.
posted by Breav at 4:04 PM on September 26, 2008

There's an excellent indepth article on "A short history of modern finance" covering this at The Economist.
posted by worldshift at 8:19 AM on October 18, 2008